Tesco accounting black hole deepens, chairman to step down

James Davey, Neil Maidment

8 Min Read

A shopper passes a Tesco supermarket in London October 5, 2011. REUTERS/Luke MacGregor

LONDON (Reuters) - Britain’s largest retailer Tesco (TSCO.L) reported a bigger than expected hole in its finances on Thursday after finding that accounting transgressions went back further than initially thought, prompting its chairman to quit.

Shares in Tesco fell 8.5 percent to an 11-year low, meaning Tesco, once the juggernaut of the retail sector, has lost half its market value this year after the accounting errors compounded a succession of profit warnings.

Chief Executive Dave Lewis, just seven weeks into the job, said he could no longer provide a full-year profit forecast for Britain’s largest private employer because he did not know how much it would cost to rebuild the firm.

With net debt rising, the pension deficit expanding and business in its home market deteriorating rapidly, the third largest retailer in the world said it was looking at all options to raise cash.

Lewis, 49, told investors there were no easy answers and they should not expect the presentation of a single new over-arching strategy but rather a series of incremental improvements that would be felt over time.

Chairman Richard Broadbent, accused by some investors of allowing Tesco to drift into crisis during his near three-year tenure, said he would step down once the new management team had bedded in and a new business plan was in place.

“Our business is operating in challenging times,” said Lewis, who joined Tesco from one of its main suppliers, Unilever (ULVR.L). “Trading conditions are tough and our underlying profitability is under pressure.”

“The UK, the balance sheet, trust and transparency and the brand of the business will be the priorities for now.”

Broadbent told reporters it was “very important that a line can be drawn under what’s happened in the past”.

“There’s a very important principle of accountability which relates to people who are in my position.”

Tesco said the overall impact from the incorrect booking of income was 263 million pounds ($421 million), up from an original estimate of 250 million pounds. When adding one-off costs such as the accounting hole and an impairment charge, its first-half statutory pretax profit was down 91 percent.

Of the 263 million pounds, around 145 million came from prior years, Tesco said. A spokesman said the figure was not big enough to require those previous results to be restated and Broadbent said the mis-statements related to when deals with suppliers should have been booked, not their validity. The accounting mistakes will affect Tesco’s second half, however.

“PRETTY HORRIBLE”

Tesco, founded by Jack Cohen as an east London market stall in 1919, grew rapidly through the 1990s to dominate the high street under the stewardship of Ian MacLaurin and Terry Leahy.

But it lost its way in the late 2000s as it cut back on investment at home to expand abroad. It then further damaged its appeal by favoring investors over shoppers with price hikes during the economic downturn in an attempt to shield profits.

Tesco now finds itself squeezed by fierce competition from discounters Aldi [ALDIEI.UL] and Lidl [LIDUK.UL] at the lower end of the market, and by rivals Waitrose and Marks & Spencer (MKS.L) at the top.

The big out-of-town stores it long championed are now also out of fashion, with more people preferring to shop little and often at local stores or online. Billionaire Warren Buffett recently cut his stake in Tesco to less than 3 percent from 4 percent after calling the purchase a “huge mistake”.

”Tesco doesn’t need to be the big sprawling business that it is,“ another large shareholder told Reuters on condition of anonymity. ”They should be in contraction mode.

“(The accounting issue) is still pretty horrible ... and it’s not closed off yet.”

The results showed the scale of the crisis.

Second-quarter organic sales in Tesco’s home market, excluding fuel and VAT sales tax, fell 5.5 percent. That compared with a 3.8 percent drop in the first quarter, which was described at the time as the worst performance in 40 years.

Net debt rose to 7.5 billion pounds from 7 billion pounds a year earlier, compared with an equity value of 14 billion pounds. The pension deficit ballooned by 800 million pounds in six months to 3.4 billion pounds.

“Tesco has had quite a few years of challenge and disappointment,” said Shore Capital analyst Clive Black. “However, we can never recall a period so damaging to the reputation of the company as the first half, 2015.”

TOUGH DECISIONS

Asked if he would need to turn to shareholders for cash, Lewis said the group was reviewing all options, but that it believed it could raise significant funds by saving costs and selling assets, before a capital increase would be considered.

That is likely to be popular with investors who have told Reuters they would rather the group sold or floated assets, such as its operations in Asia and central and eastern Europe, before they would consider a rights issue.

Lewis said he had been visiting his British stores to get an idea of how shoppers view the retailer, but that the accounting probe had left him with no time to visit stores abroad, which he planned to do next week.

Tesco Asia, one of the assets that could be sold or spun off, saw trading profit fall 9.2 percent. The Europe business was up 42 percent, but that was from a low base, and it is thought to have fewer potential buyers.

Tesco Bank reported strong results.

Tesco said last month it had discovered an overstatement in its first-half profit forecast of 250 million pounds due to the way it booked payments from deals with food suppliers. Having been tipped off by a whistleblower, Lewis called in accountants Deloitte and the lawyers Freshfields to investigate.

Having captured 6.3 million documents and reviewed 18,000 invoices, it said on Thursday that the overall impact had now risen to 263 million pounds. There was no evidence of material issues outside of the British food business and no one had gained financially from the overstatement, Lewis said.

Eight senior members of staff, including UK managing director Chris Bush, remain suspended, in a serious blow to a firm as it gears up for the key Christmas trading period.

Bush and the suspended staff have not commented publicly on the issue. The internal investigation has now been shut, leaving Britain’s financial regulator, the FCA, to investigate further. FCA investigations sometimes take over a year.

Lewis said the fate of the eight would depend on the outcome of the FCA probe.

Tesco said severance payouts of one year’s salary due to former CEO Phil Clarke and former CFO Laurie McIlwee had been suspended pending the outcome of the FCA investigation.

Clarke, a 40-year Tesco veteran who was ousted in July, will, however, still be paid a monthly salary until he officially ceases to be an employee on Jan. 19. Lewis said he was not currently in contact in Clarke.

“The Deloitte investigation established the ‘what’, the size of the issue,” Lewis said. “The FCA will establish the ‘why’ and the ‘how’,” he said, adding that Tesco did not expect, at this stage, to book any further charges in connection with the issue.